Many first-time traders ask why they should trade a futures or options contract when they can simply buy shares.
The answer is that derivatives provide more ways to manage a position. An investor can use them to protect a portfolio, take a view on Nifty, or trade when prices are falling. A trader may also take a position without paying the full contract value upfront.
These benefits do not make derivatives safe or easy. SEBI reported that 93% of individual traders in equity F&O incurred losses between FY22 and FY24. The study also reported aggregate losses of more than ₹1.8 lakh crore during the period.
Derivatives can help you hedge an investment, take market exposure with a smaller initial amount, and trade when prices are rising or falling. Futures and options also offer several strategy choices. The risks are equally important. Margin, lot size, expiry, time decay, and option selling can affect the result. Derivatives should be used only after you understand the contract and know how much you can lose.
Table of Contents
- What Are Derivatives?
- How Do Derivatives Work?
- Examples With Numbers
- Key Features of Derivatives
- Advantages of Derivatives
- Risks and Limitations
- Tips for Beginners
- Futures and Options
- Mistakes to Avoid
- Who Should Use Derivatives?
- Frequently Asked Questions
What Are Derivatives?
A derivative is a contract linked to the price of another asset.
That asset could be:
- A share such as Reliance Industries
- An index such as Nifty 50
- A currency pair
- A commodity such as gold
You do not usually own the underlying asset when you trade a derivative. Instead, you hold a contract whose value changes when the underlying price changes.
The two most common equity derivatives in India are futures and options.
A futures contract creates an obligation to buy or sell at the agreed terms. An option gives the buyer a right, but not an obligation, to buy or sell. The buyer pays a premium for this right. The seller receives the premium and accepts the obligation.
NSE publishes contract details for index futures, index options, futures on individual securities and options on individual securities. These details include expiry, lot size, and other trading terms.
How Do Derivatives Work?
Select the underlying asset
The underlying may be an index such as Nifty 50, an eligible individual share, a currency pair, or a commodity.
Choose the contract
You then choose between futures and options.
Futures provide direct price exposure. A rise in the underlying can help a long futures position, while a fall can hurt it.
Options work differently. An option buyer pays a premium and receives a right under the contract. The option may expire without value if the underlying does not move enough in the expected direction.
Check the contract details
Look at:
- Expiry date
- Lot size
- Strike price
- Premium
- Trading volume
- Buying and selling prices
The latest contract details should be checked on the NSE website because exchange specifications may change.
Calculate the total amount
Do not look only at the price shown on the screen.
For an option, multiply the premium by the lot size. For a futures position, understand the full contract value and required margin.
Decide how you will exit
Know your exit price before entering. A position should not be held simply because the price has moved against you.
Examples With Numbers
The examples below are for learning. The lot size and margin used here are assumptions, not live trading figures.
Futures example
Assume Nifty is at 24,000. Assume the contract lot size is 65 units.
The contract value would be:
24,000×65=₹15,60,000
Now assume the broker requires 12% as margin for this example.
The margin would be:
₹15,60,000×12%=₹1,87,200
If Nifty rises by 300 points, the gain before charges would be:
300×65=₹19,500
A fall of 300 points would produce a loss of ₹19,500.
The point is that the position is linked to a contract worth ₹15.6 lakh, even though the assumed margin is lower. This is why a trader must calculate the possible loss before entering.
Options example
Assume a Nifty call option has a premium of ₹150 per unit and the assumed lot size is 65.
The premium paid would be:
₹150×65=₹9,750
If the option expires without value, the buyer may lose the ₹9,750 premium, plus applicable charges.
If the option is later worth ₹300 per unit, its contract value would be:
₹300×65=₹19,500
The approximate gain before charges would be:
₹19,500−₹9,750=₹9,750
The actual result can differ because option prices are affected by the underlying price, strike price, expiry, volatility, and demand.
Key Features of Derivatives
- Underlying asset: The contract derives its value from a share, index, currency, or commodity.
- Expiry date: The contract remains valid until the expiry date specified by the exchange.
- Lot size: Orders are placed in exchange-defined quantities rather than individual units.
- Margin: Futures and option selling generally require margin.
- Premium: An option buyer pays a premium for the right under the contract.
- Leverage: A trader may control a contract value that is greater than the initial amount deposited.
- Price exposure: Traders can gain or lose from price movement without owning the underlying shares.
- Exchange rules: The exchange defines contract specifications, settlement terms, and other trading conditions.
Advantages of Derivatives
1. Protection for an existing investment
Consider an investor who owns several shares and expects the market to weaken for a short period. Selling index futures or buying put options may help reduce the effect of that fall.
This is called hedging. It is similar to buying protection for a position.
A hedge does not guarantee that the entire loss will be covered. The portfolio and the index may move by different amounts.
2. Lower upfront capital for some trades
A futures trader generally deposits margin rather than paying the entire contract value. This can make it possible to take a position with less money upfront.
That does not mean the position is low risk. The contract still represents a much larger exposure than the amount deposited.
3. Ways to trade a falling market
Share investors often make money when prices rise. Derivatives offer other choices.
A trader expecting a fall may sell futures or buy put options. The position can lose money if the fall does not happen, happens too late, or is smaller than expected.
4. Exposure to a broad index
Buying an index derivative gives exposure linked to the index instead of one company.
For example, Nifty 50 contracts are based on the Nifty 50 Index. This may be useful for someone who has a view on the wider market instead of a particular share.
5. More strategy choices
Options allow different trade structures.
A trader may buy a call, buy a put, or combine contracts in a spread. A spread involves buying and selling different options together to define the trade more clearly.
These strategies are not automatically safer. The trader must understand the maximum loss, maximum gain, break-even point, and expiry effect.
6. Opportunity across market segments
Derivative contracts are available on selected shares, indices, currencies and commodities. This gives traders more markets to study.
More choices can also create more temptation to trade. A trader does not need to take a position in every market.
7. Premium income in selected situations
An investor holding shares may study a covered call. This involves selling a call option against the shares held.
The seller receives a premium, but the strategy has conditions. A sharp rise in the share price may limit the benefit from further gains. Selling an uncovered option can create a much larger loss.
8. Support for price discovery
The derivatives market brings together buyers and sellers with different expectations. Their orders contribute to the process of price discovery.
In simple terms, trading activity helps the market arrive at a price based on available information and expectations. It does not predict the future with certainty.
Risks and Limitations
1. Margin can create oversized positions
A trader may take a position that is too large because the broker asks for only part of the contract value upfront.
The loss should be calculated in rupees, not only as a percentage of the margin.
2. Futures can create continuing losses
A futures position does not have a fixed maximum loss for the buyer. If the underlying keeps moving in the wrong direction, the loss can increase.
3. Options can lose value with time
An option buyer needs the underlying to move in the expected direction within a limited period. If the move does not happen soon enough, the option premium may fall.
4. Option selling needs extra care
The premium received by an option seller is limited. The potential loss can be much larger, especially when the position is not protected by another option or asset.
5. Some contracts are difficult to exit
Contracts with low trading activity may have a wide difference between the buying price and selling price. This can increase the cost of closing the trade.
6. Charges reduce the final result
Brokerage, exchange charges, taxes, and other statutory charges reduce profits. Always check the result after charges.
7. Trading behaviour matters
A trader who increases the position after a loss or keeps moving the stop loss may turn a small loss into a large one.
SEBI’s study found that most individual F&O traders lost money during FY22 to FY24. The figure is a reminder to treat derivatives as a high-risk product, not as a quick income source.
Tips for Beginners
- Learn one product at a time.
- Understand the lot size before calculating the trade amount.
- Check the latest exchange contract details.
- Find out the margin required by the broker.
- Calculate the loss if the underlying moves against you.
- Keep money aside for an adverse move.
- Avoid using all available funds.
- Do not sell options before understanding the possible loss.
- Do not buy an option simply because the premium is low.
- Include every charge in the profit and loss calculation.
- Maintain a record of each trade.
- Begin with observation or paper trading if the contract mechanics are new to you.
Futures and Options
| Point | Futures | Options |
| What the buyer receives | A contract obligation | A right under the contract |
| Initial amount | Margin | Premium |
| Buyer obligation | Yes | No |
| Effect of time decay | Not the same as options | Can reduce option value |
| Buyer loss | Can be large | Usually limited to premium |
| Seller risk | Can be large | Can be large |
| Common use | Trading and hedging | Hedging and structured trades |
Mistakes to Avoid
1. Looking only at the premium
A premium of ₹100 does not mean the trade costs ₹100. The amount is multiplied by the lot size.
Do this instead: Calculate the full premium before placing the order.
2. Treating margin as the maximum loss
Margin is the amount required to open or maintain a position. It is not always the maximum amount you can lose.
Do this instead: Calculate the loss for different price movements.
3. Buying options without checking expiry
The option may lose value if the expected price movement takes too long.
Do this instead: Check how much time is left and what move is needed to reach break-even.
4. Selling options without a plan
The premium may look attractive, but an unexpected move can create a large loss.
Do this instead: Use a defined risk structure and know the margin requirement.
5. Using the entire account balance
A trader may be forced to close a position if additional funds are needed.
Do this instead: Leave a cash reserve.
6. Trading because of a tip
A message on WhatsApp or social media rarely explains the entry, exit, risk or contract details.
Do this instead: Trade only when you understand the position yourself.
Who Should Use Derivatives?
Derivatives may suit an active trader who can monitor positions and understands how margin and expiry work.
They may also suit an investor who wants to hedge a sizeable portfolio.
They may not suit someone who:
- Is using money needed for living expenses.
- Cannot monitor the position.
- Does not understand leverage.
- Expects guaranteed returns.
- Has not learnt how the contract works.
Conclusion
Derivatives can help traders hedge, trade falling markets, and take exposure to an index or selected security. They also offer more strategy choices than direct share buying. The trade-off is risk. Margin, expiry, time decay, and option selling can affect the result quickly. Before placing a trade, check the current contract details, calculate the possible rupee loss, and keep enough money aside for an adverse move. A derivative should be used for a clear reason, not simply because the required initial amount looks small.
Frequently Asked Questions
1. What are the main advantages of derivatives?
Derivatives can help with hedging, capital use, falling market strategies, index exposure, and flexible trade structures. These benefits come with significant risk.
2. Are derivatives suitable for beginners?
Beginners can learn about derivatives, but they should not start live trading before understanding margin, lot size, expiry, premium and possible loss.
3. Can derivatives protect a stock portfolio?
They can reduce the effect of an adverse price movement. They may not cover the entire loss because the portfolio and the derivative may not move equally.
4. Can I profit when the market falls?
You may profit by selling futures or buying put options if the market falls as expected. The position can lose money if the fall does not happen within the required time.
5. What is the difference between futures and options?
A futures contract creates an obligation. An option gives the buyer a right without an obligation. The option buyer pays a premium for that right.
6. Can derivatives cause a loss greater than the initial amount?
Yes. Futures and uncovered option selling can create losses greater than the initial amount deposited. An option buyer’s loss is generally limited to the premium paid, excluding charges.
7. How much money is needed to trade derivatives?
It depends on the contract, lot size, market price, premium, margin, and strategy. Check the latest exchange information and the broker’s live margin requirements before trading.
We hope that you are clear about the topic. But there is more to learn and explore when it comes to the stock market, commodity and hence we bring you the important topics and areas that you should know:
